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IN THE MATTER OF A SETTLEMENT HEARING
PURSUANT TO SECTION 24.4 OF BY-LAW NO. 1 OF
THE MUTUAL FUND DEALERS ASSOCIATION OF CANADA

Re: Credential Asset Management Inc.

Heard: December 10, 2021 by electronic hearing in Vancouver, British Columbia
Reasons For Decision: March 9, 2022

Reasons For Decision

Hearing Panel of the Pacific Regional Council:

  • Joseph A. Bernardo, Chair
  • Michelle Leung, Industry Representative

Appearances:

Shelly Feld, Director, Chief of Litigation for the Mutual Fund Dealers Association of Canada
Yasmin Lalani, SVP, Chief Legal Officer, Chief Governance Officer, Credential Asset Management Inc.
David Di Paolo, Counsel for Respondent
Caitlin Sainsbury, Counsel for Respondent

I. INTRODUCTION

  1. On December 10, 2021, the Hearing Panel was asked in a closed session to consider a settlement agreement dated November 30, 2021 (“Settlement Agreement”) made between the staff (“Staff”) of the Mutual Fund Dealer’s Association of Canada (“MFDA”) and Credential Asset Management Inc. (the “Respondent”). The Settlement Agreement is attached as Schedule “1”.
  2. The Hearing Panel accepted the Settlement Agreement for the following reasons.

II. AGREED LAW AND FACTS

Regulatory framework

  1. The Respondent has been a Member of the MFDA since January 11, 2002, and is registered in every province. It provides mutual fund dealer services for different financial institution partners throughout Canada (Partner Institutions). The Respondent’s head office is located in Vancouver, British Columbia.
  2. MFDA Rule 2.5.1 provides that:
    1. Each Member is responsible for establishing, implementing and maintaining policies and procedures to ensure the handling of its business is in accordance with the By-laws, Rules and Policies and with applicable securities legislation.
  3. The securities legislation applicable to Members includes the uniform regulations, known as National Instruments, adopted by the statutory securities regulator in each province and territor
  4. Under National Instrument 81-102 — Mutual Funds, a “principal distributor” is defined as an entity to which a mutual fund has granted an exclusive or preferential right to distribute its securities. A dealer that distributes a mutual fund’s securities other than through a principal distributor arrangement is defined as a “participating dealer”.
    1. Section 1.1, National Instrument 81-102 — Mutual Funds.
  5. National Instrument 81-105 — Mutual Fund Sales Practices (NI 81-105) prohibits sales practices and compensation arrangements that incentivize, or risk incentivizing, industry participants to prioritize their own financial gain over the best interests of investors. Among other things, NI 81-105 prohibits dealers from providing incentives that encourage its Approved Persons to recommend:
    1. as a participating dealer, the funds of one mutual fund family over those of another fund family; or
    2. a mutual fund of which it is a principal distributor over a fund of which it is a participating dealer.
    1. Sections 4.1 and 4.2, National Instrument 81-105 — Mutual Fund Sales Practices.
    2. Companion Policy 81-105CP to National Instrument 81-105, at paras. 2.1(1), 2.1.(1), and 2.1.(2).
  6. These prohibitions overlap with the obligations that Rule 2.1.4 imposes on Members regarding the management of conflicts of interest. As the conduct described in the Settlement Agreement took place before the Rule was amended on June 30, 2021, the previous version applies to this case. It specified that Members must:
    1. “be aware of the possibility of conflicts of interest arising between the interests of the Member or Approved Person and the interests of the client”;
    2. address a conflict or potential conflict of interest “by the exercise of responsible business judgment influenced only by the best interests of the client”; and
    3. “develop and maintain written policies and procedures to ensure compliance” with the Rul

III. FACTS

  1. The Respondent provided mutual fund dealer services to Partner Institutions through a dual employment arrangement, whereby employees of the Partner Institutions were concurrently employed as Approved Persons, and supervised as such, by the Respondent (Representatives). Under participation agreements made between the Respondent and the Partner Institutions, the Respondent shared the mutual fund sales revenue generated by Representatives with their respective Partner Institution employers.
  2. In November 2011, the Respondent launched its “OnCourse Program”, under which:
    1. A branded suite of mutual funds was promoted to the clients of Partner Institutions. Some of the funds were managed by a related party, while others were managed by a third party;
    2. The Respondent was the principal distributor of the branded related party mutual funds, which were managed by Northwest & Ethical Investments LP (NEI);
    3. The Respondent was a participating dealer of the branded third party mutual funds, which were managed by AGF Investments Inc. (AGF).
  3. Outside of the OnCourse Program, the Respondent offered other series of NEI and AGF mutual funds that were essentially the same as the branded funds.
  4. The trailing commissions the Respondent received for selling branded mutual funds inside the OnCourse Program were higher than the commissions it received for selling the non-branded versions outside of the program.
    1. For the branded NEI funds, the Respondent received trailing commissions that on average were 27 basis points higher.
    2. For the branded AGF funds, the Respondent received trailing commissions that on average were 15 basis points higher.
  5. In 2017, a MFDA compliance examination revealed that the Respondent had participated in arrangements that offered Approved Persons incentives to promote the sale of certain mutual funds over others.
  6. Between November 2011 and May 2017:
    1. The Respondent offered two Approved Persons employed at its head office performance bonuses tied to sales targets for the branded mutual funds. No such bonuses were offered for sales of the non-branded versions.
    2. Certain Partner Institutions offered incentives to their Representatives tied to the sale of the branded mutual funds, but not the non-branded versions, including:
      1. performance bonuses for achieving OnCourse Program sales targets;
      2. increased commissions for making new sales of, or converting existing client assets to, mutual funds within the OnCourse Program; and
      3. expecting Representatives to offer clients OnCourse products unless the clients specifically requested otherwise.
    3. One Partner Institution paid to its Representatives 5% of the profits generated from their respective sales of NEI mutual funds.
  7. The performance compensation received by Representatives attributable to sales of mutual funds within the OnCourse Program was as follows:
    1. In 2015, a total of 979 Representatives sold $307,140,547 of branded mutual funds. 91 of the Representatives collectively received $65,289 in extra compensation on sales of $37,578,793.
    2. In 2016, a total of 1,162 Representatives sold $311,894,967 of branded mutual funds. 91 of the Representatives collectively received $67,177 in extra compensation on sales of $28,162,308.
  8. The fees that the Respondent’s clients paid on purchases of branded funds were not higher than those for the non-branded versions.
  9. The Respondent was a participating dealer of socially responsible mutual funds and, in a small number of cases, the principal distributor of them. In January 2016, one of the Partner Institutions introduced incentives to encourage Representatives to promote the sale of such funds, including:
    1. bonus compensation that was not payable in respect of other types of funds; and
    2. credit for soliciting new investments and converting existing client assets into socially responsible mutual funds.
  10. These incentives resulted in Representatives receiving the following extra performance based compensation:
    1. In 2016, 47 Representatives received a total of $250,576.
    2. In 2017, 49 Representatives received a total of $394,554.
  11. The Respondent fully co-operated with the MFDA in its review of the issues arising from the 2017 compliance examination. Following the examination, the Respondent:
    1. In May 2017, eliminated bonuses on OnCourse Program sales paid to Approved Persons employed at the head office, and instructed the Partner Institutions to end all OnCourse Program incentives and instead institute bonus structures that treated the sales of all mutual funds equally.
    2. In 2018, directed the Partner Institutions to end preferential incentives for socially responsible mutual funds.
    3. Instituted internal policies and procedures that:
      1. specifically state that NI 81-105 prohibits dealers from preferentially recommending one mutual fund family over another or providing incentives to Approved Persons to do so;
      2. require Partner Institutions to end any practices that incentivize Representatives to preferentially solicit investments in the OnCourse Program or socially responsible mutual funds; and
      3. establish a conflicts of interest committee led by senior management to review conflicts of interest related to compensation.
  12. The Settlement Agreement is part of a regulatory initiative undertaken jointly by the MFDA and the British Columbia Securities Commission (BCSC). The Respondent has entered into a separate settlement agreement with the BCSC’s Director of Enforcement concerning the same conduct (BCSC Settlement), a copy of which was tendered into the record at the hearing. In the BCSC Settlement, the Respondent:
    1. Acknowledged that it failed to establish adequate supervisory measures to ensure that:
      1. its head office Approved Persons and Representatives were not provided with preferential incentives; and
      2. the Respondent and the individuals acting on its behalf complied with securities legislation,

      contrary to NI 81-105 and National Instrument 31-103 — Registration Requirements, Exemptions and Ongoing Registrant Obligations, respectively.

    2. Agreed to pay a fine of $300,000.

IV. MISCONDUCT

  1. The Respondent acknowledges that between November 2011 and May 2017, it failed to:
    1. establish and maintain adequate policies and procedures, controls and supervisory measures to ensure that it complied with securities legislation, contrary to Rule 2.5.1; and
    2. address conflicts of interest by the exercise of responsible business judgment influenced only by the best interests of its clients, contrary to Rule1.4.
  2. The Respondent’s admission of fault is plainly supported by the agreed upon facts, which establish that during the relevant period the Respondent contravened sections 4.1 and 4.2 of NI 81-105 by:
    1. providing performance bonuses to two Approved Persons at its head office that were tied to meeting sales targets for OnCourse Program mutual funds;
    2. sharing OnCourse Program mutual fund sales revenues with Partner Institutions from which Representatives were paid incentives that encouraged them to recommend those funds over others; and
    3. sharing revenues from the sale of socially responsible mutual funds with a Partner Institution from which Representatives were paid incentives that encouraged them to recommend those funds over other mutual funds.

V. APPLICABLE STANDARD

  1. The Settlement Agreement came before the Hearing Panel further to section 24.4 of MFDA By-law No. 1, the provision that sets out settlement hearing procedures and grants hearing panels the jurisdiction to accept or reject settlements.
  2. Subsection 24.4.3 defines a hearing panel’s discretion with respect to settlements in the narrowest of terms, stating simply that a panel may:
    1. accept the settlement agreement; or
    2. reject it.

    In short, a settlement hearing panel has no authority to impose its own preferred outcome on the parties.

  3. It is well-established that settlements are to be encouraged and supported. This is because enabling the efficient allocation of limited enforcement resources serves to advance the MFDA’s core regulatory goal of protecting the investing public. As the British Columbia Court of Appeal stated with respect to a BCSC settlement:
    1. Settlements assist the Commission to ensure that its overriding objective, the protection of the public, is met. Settlements proscribe activities that are harmful to the public. In so doing, they are effective in accomplishing the purposes of the statute. They provide means of reaching a flexible remedy that is tailored to address the interests of both the Commission and the person under investigation.
      1. British Columbia Securities Commission v. Seifert, 2007 BCCA 484, at para. 49.
  4. Moreover, settlements deserve a measure of deference precisely because they are negotiated: emerging as a compromise between the competing perspectives of the litigants, a settlement necessarily represents a pragmatic and nuanced resolution of the facts and issues that has been achieved through the best efforts of the persons best situated to assess them.
    1. Seifert, supra, at paras. 26 and 31.
    2. Professional Investments (Kingston) Inc. (Re), 2009 LNCMFDA 9, at para. 13.
    3. Fike (Re), 2017 LNCMFDA 279, at para. 22.
    4. Investia Financial Services Inc. (Re), 2019 LNCMFDA 18, at para. 32.
  5. From this line of reasoning, MFDA settlement hearing panels have consistently concluded that a hearing panel ought not to assess a proposed settlement outcome against what it might itself have deemed appropriate were it exercising its own independent discretion. Instead, a hearing panel’s responsibility is to accept the agreed upon facts at face value and weigh the proposed outcome against the objectives of protecting the investing public and the integrity of the mutual fund industry. An outcome that clearly falls “outside a reasonable range of appropriateness” may properly be rejected. Otherwise, it is incumbent on the hearing panel to accept it.
    1. Sterling Mutuals Inc. (Re), MFDA File No. 20080, September 3, 2008, at para. 37, citing the reasoning in Milewski (Re), [1999] I.D.A.C.D. No. 17 at p.11, Ontario District Council Decision dated July 28, 1999.
    2. Professional Investments, supra.
    3. Fike, supra, at para. 23.
    4. Investia, supra, at para. 33.

VI. ASSESSING APPROPRIATENESS

  1. In assessing the appropriateness of a settlement outcome, a hearing panel must be guided by the same overarching principles that inform sanctioning generally.
  2. Penalties in securities regulatory proceedings are required to be forward looking and preventative in orientation, not retrospective or punitive. They are appropriate only to the extent that they are rationally supportable as necessary to protect the investing public from future harm. The fact that severe penalties can always be presumed to have a deterrent effect does not justify a reflexive reliance on them. To be reasonable, a penalty must be proportional to the misconduct. As the Supreme Court of Canada indicated in Cartaway Resources Corp., the importance of deterrence when “imposing a sanction… will vary according to the breach… and the circumstances of the person charged”.
    1. Pezim v. British Columbia (Superintendent of Brokers), [1994] 2 S.C.R. 557, at paras. 59 and 68.
    2. Canada (Minister of Citizenship and Immigration) v. Vavilov, 2019 SCC 65 at paras. 14, 85.
    3. Cartaway Resources Corp. (Re), [2004] 1 S.C.R. 672 at para. 61.
  3. In other words, regardless of whether a hearing panel is ordering sanctions in a contested hearing or considering a proposed settlement outcome, the hearing panel’s decision must be based on a thorough and case specific assessment of the misconduct and the objective risk it presents to the investing public going forward.
  4. The key factors to be considered in that exercise are well established, and summarized in the MFDA’s Sanction Guidelines. Neither the Guidelines, nor the previous hearing panel decisions from which they are derived, establish benchmarks for the levying of penalties. A MFDA hearing panel cannot fetter its discretion by treating the decisions of other panels as binding. Rather, for an administrative tribunal the value of precedent lies in the general principles it articulates and the guidance it provides for interpreting those principles in different contexts.
  5. The relative emphasis or importance to be placed on any single sanctioning factor will depend on the nature and scope of the misconduct. The key sanctioning factors in this case are:
    1. The need for effective general deterrence.
    2. The importance of ensuring public confidence in the mutual fund industry and the fairness of the capital markets. This requires sanctions that accurately reflect the mitigating and aggravating factors disclosed by the facts.
    3. The seriousness of the misconduct.
    4. The degree to which the Respondent has accepted responsibility for its misconduct and voluntarily undertaken corrective action.
    5. The degree to which clients were harmed and the Respondent received improper benefits.
    6. The fact the BCSC has separately sanctioned the Respondent for the same conduct.
    7. The guidance provided by previous decisions made in similar circumstances.

VII. PROPOSED SANCTIONS

  1. The Settlement Agreement contemplates that the Respondent pay:
    1. a fine of $280,000; and
    2. costs of $20,000.
  2. There appear to be only a limited number of settlement precedents that address contraventions of NI 81-105.
  3. The Hearing Panel was presented with two MFDA settlements. In one case (Quadrus), the parties agreed to a fine of $600,000 and costs of $25,000; in the other case (Sun Life), the fine was $1.7 million and costs were $100,000.
    1. Quadrus Investment Services Ltd. (Re), MFDA File No. 202166, November 23, 2021.
    2. Sun Life Financial Services (Canada) Inc. (Re), 2018 LNCMFDA 3.
  4. The Hearing Panel was also presented with Ontario Securities Commission (OSC) settlement decisions involving NI 81-105. In these cases, the fines ranged from between $800,000 and $1.5 million and averaged about $1,075 million; costs were between $20,000 and $150,000, but averaged about $117,000.
    1. Sentry Investments Inc. (Re,) 2017 LNONOSC 189.
    2. Mackenzie Financial Corp. (Re), 2018 LNONOSC 191.
    3. 1832 Asset Management L.P. (Re), 2018 LNONOSC 212.
    4. Royal Mutual Funds Inc., (Re), 2018 LNONOSC 311.
  5. Since commission enforcement decisions are concerned with breaches of securities legislation and not the Rules, for MFDA proceedings the guidance they provide is usually of a more general or policy nature. In this case, however, the OSC settlement precedents directly inform the assessment of appropriateness because they address breaches of NI 81-105, namely, the very harm caused by the Respondent’s failure to comply with Rules 2.5.1 and 2.1.4.
  6. Relevance, however, is not the same as weight. As Chief Litigation Counsel observed in oral submissions, all but one of the settlement precedents involved misconduct more aggravated than the Respondent’
    1. In Sun Life, supra, a MFDA compliance audit revealed that the misuse of preferential incentives was only one element in an extensive array of misconduct that put clients at risk. These included: the ineffective supervision of leveraging activity and concentration risk in client accounts; procedures that failed to ensure the suitability of deferred sales charge mutual funds for clients; and failures in the timely reporting of client complaints and other events to the MFDA. This was all compounded by the respondent’s failure, as revealed by a follow up audit, to correct its faulty practices.
    2. In Royal, supra, an OSC precedent, Approved Persons employed by the respondent received over $25,000,000 in preferential incentive compensation. By contrast, the various amounts of improper compensation disclosed in the Settlement Agreement add up to less than $800,000.
    3. The other OSC settlement precedents are not concerned with preferential incentives. Rather, they address the related problem of dealers contravening NI 81-105 by providing sales incentives so excessive that they risk encouraging Approved Persons to generally make recommendations on the basis of their own self-interest rather than the best interests of their clients.
  7. Of the settlement precedents, only Quadrus, supra, involved a contravention of NI 81-105 that approximates that described in the Settlement Agreement. In that case, the substance of the misconduct similarly consisted of a relatively discrete failure to establish policies and procedures sufficient to prevent preferential incentive practices and similarly involved a respondent that took prompt voluntary pro-active action to correct the problem once notified.
  8. Overall, the guidance provided by the settlement precedents is limited but nonetheless instructive.
    1. The cases are uniformly clear in explaining that an incentive strategy that fails to observe NI 81-105 necessarily constitutes grave misconduct because, being structurally misaligned with client interests, it constitutes a systemic contravention of Rules 2.5.1 and 2.1.4 that puts clients at risk of harm on a continuing basis.
    2. They affirm the principle that, in order to fall within an appropriate range of appropriateness, a settlement outcome must be proportionate to the misconduct.
  9. The Respondent received higher trailing commissions from sales of branded mutual funds in the OnCourse program than from its sales of the same funds outside of the program. However, the extent to which the improper incentives actually biased recommendations is unclear: in each of 2015 and 2016, fewer than 10% of the Representatives received extra compensation on roughly 12% and 9%, respectively, of the total branded mutual fund sales in those years. As for the preferential incentives one Partner Institution put in place to encourage recommendations of socially responsible mutual funds, the Settlement Agreement gives no indication what benefit, if any, the Respondent received from the initiative. Whatever the net total benefit the Respondent accrued from the preferential incentives may have been, it appears to have been relatively modest.
  10. The facts do not establish financial harm to clients. None of the preferential incentives associated with either the OnCourse Program or the promotion of socially responsible mutual funds resulted in clients paying any higher fees or costs than otherwise. Nonetheless, it is reasonable to infer from the simple fact that extra compensation was paid to Representatives that at least some clients were disadvantaged by way of receiving recommendations that were not based exclusively on their best interests.
  11. Entering into the Settlement Agreement is a concrete demonstration that the Respondent accepts responsibility for its lapses. More importantly, following the 2017 compliance examination the Respondent promptly terminated the use of improper incentives and then proceeded to take the actions necessary to bring its policies and procedures into compliance with Rules 2.5.1 and 2.1.4. As Sun Life, supra, demonstrates, it cannot be simply assumed that a dealer once notified will proactively introduce the substantive organizational changes required to prevent future contraventions. The fact the Respondent did so is a meaningful mitigating factor.
  12. The fines and costs payable by the Respondent under the Settlement Agreement and the BCSC Settlement collectively add up to $600,000. This is the same as the fine agreed upon in the Quadrus, supra, It is also noteworthy that the BCSC Settlement states that the public interest does not require any further sanctions in the form of enforcement orders under the Securities Act, RSBC 1996, c. 418. While not determinative, the co-ordinated involvement of the province’s senior securities regulator and its views on what investor protection requires going forward are, by definition, germane to any consideration of the Settlement Agreement’s appropriateness.

VIII. DECISION

  1. The only question in this case is whether the sanctions contemplated by the Settlement Agreement represent an adequate response to the Respondent’s undeniably serious misconduct.
  2. With respect to specific deterrence, the Respondent’s promptness and effectiveness in correcting its supervisory flaws speaks to a tangible commitment to avoid future contraventions that eliminates the need for directed compliance measures. As for general deterrence, on the available facts the proposed financial penalty appears proportionate to the specific character of the misconduct.
  3. As the proposed outcome cannot be said to fall outside a reasonable range of appropriateness, the Hearing Panel accepted the Settlement Agreement.
  • Joseph A. Bernardo
    Joseph A. Bernardo
    Chair
  • Michelle Leung
    Michelle Leung
    Industry Representative

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